EU officials pile pressure on Italy to keep government afloat

MILAN (Reuters) - European Union officials warned Italy on Sunday not to let politics ruin recovery prospects and upset debt markets in a week that could signal the end of Erico Letta's fragile five-month-old government.

Olli Rehn and Manuel Barroso threw their weight behind Letta, who also appealed for stability this weekend before a Senate vote on Wednesday on whether Silvio Berlusconi should be expelled from parliament following a conviction for tax fraud.

"I believe it is of paramount importance to keep political stability in the country to ensure a recovery, mainly because the latest data show the economy remains relativity weak, without clearly indicating a return to growth," Rehn, the EU's top economic official, told Italian business daily Il Sole 24 Ore.

Italian industrial output was much weaker than expected in July, falling 1.1 percent and undermining expectations that the country might emerge from its longest post-war recession in the third quarter.

Political instability has thwarted attempts to make the economy more competitive and whittle down Italy's government debt burden, one of the world's biggest.

Berlusconi's centre-right allies have threatened to sink the government if Wednesday's vote goes against him.

Letta's left-right coalition, which needs the backing of Berlusconi's People of Freedom party to survive, has bickered since it was formed in April but the infighting has intensified since Berlusconi was sentenced last month.

Barroso, the president of the European Commission, said he did not want to interfere with Italy's internal politics but it was his duty to demand a greater sense of responsibility from all political forces.

"Italy needs systemic stability. It's one of the big countries of the euro zone: when signs of political instability emerge there are repercussions on the markets," Barroso told Rome-based daily il Messaggero. "In this moment being wise is fundamental"

Letta himself made an impassioned appeal for political stability on Saturday, warning that a political crisis would push up borrowing costs and throw Italy into chaos.

In the latest auction, borrowing costs on three-year bonds reached their highest level in almost a year.

Rehn said he was confident Italy would find a way to meet its targeted budget deficit of 2.9 percent of output this year, adding that it was up to the government to decide how to achieve that.

However, he said Italy had done less than was expected of it in terms of economic reforms and this had weighed on growth and employment.